Enron Scandal: The Case of Accounting Fraud

Topics: Enron Scandal

Accounting fraud is a term used to refer to the act of manipulation of the financial statements of a business organization with the intention of misleading the public and other stakeholders on the financial health of the organization. Accounting fraud can be committed either for the intention of giving investors and potential investors a positive image so that they can invest or give the government a negative image of the financial health of an organization so that the organization can be able to evade.

One of the most discussed cases of accounting fraud is the Enron Scandal. This paper evaluates Enron Scandal with a focus on the factors that qualify it as a case of accounting fraud, proof of cooperate governance failure, and the ethical issues that were involved.

Enron Corporation was an American company that specialized in energy and was based in Texas. The Enron Scandal became known to the public in 2001 October. The scandal is believed to have taken place at a time when the company was at its peak.

Its shares were worth $90.75. After the scandal, it took the company less than 2 months to be declared bankrupt. At the time the company was being declared bankrupt, their shares were worth $0.26. During the fiscal year that came before the scandal, the company had recorded revenue of almost $101 billion. Before the scandal was reported, the company offered employment to more than 20000 people.

In less than one year, Enron had changed from being considered one of the most innovative companies in the US to one that was largely associated with corruption.

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The company gave the public the wrong impression on what the performance of the company was. They exaggerated profits even for businesses that they did not get any income from so that they could dupe investors into buying shares because of the belief that the company has a prospect of great returns. The corporate scandal is basically fraud because it led investors into buying shares of a company that was not doing well financially by giving misleading reports on the performances of the assets owned by the company. Therefore, the company was known to be doing well for years while it was not. Debts were piling up, and the dark details of such endeavors were hidden from the public and investors.

The company was involved in accounting fraud activities that were characterized by the use of mark-to-market accounting. This is a technique that can be used for accounting fraud because it involves measuring the value of security using market value and not the book value. When this technique is used, there are various factors that are hidden from members of the public. A good example of such factors is debts. For instance, when a company acquires an asset using borrowed money, they are likely to earn some revenue from that asset. However, when calculating the profit earned from such assets, it is required that the debts be factored in. Failure to consider the debt that was used in the acquisition of the asset will lead to the perception that the asset is doing extraordinarily well. However, things are likely to become clear when the time for debt paying comes. As far as trading securities were concerned, mark-to-market accounting worked miracles. However, the results were disastrous for the actual business.

As far as accounting standards are concerned, Enron was deceitful in four ways. The first way in which this company was deceitful is manipulation of intent which was seen in the purpose for which they used Special Purpose Entities (SPE’s). This was done with the purpose of hiding debts and thus manipulating the reports that would be given regarding their revenues and profits. The second violation of accounting standards was the use of mark-to-model accounting, which enabled them to use estimates that were produced by their analysis prior to certain investments instead of using the actual outcome of the investments. Through the violation of accounting standards in this manner, the company effectively gave itself a false sense of stability that was only known by the executive leaders. The third violation was the fact that some of the senior executives were principles in SPE’s used which means that there was a conflict of interest. This is a violation that they exploited so that they could enrich themselves at the expense of the company. Finally, Enron executives violated accounting principles by posting large amounts of the company’s stock as collateral so that they can be able to back the financing of SPE’s. This is a factor that led to an entire financial structure that was vulnerable to a decline in the price of their stock. There are various reasons that would have led to a negative response to the price of the company’s stock.

There are some ethical issues that were involved in this scandal. For instance, it is the ethical reasonability of a company that is publicly traded such as Enron to be truthful to their investors and the public at large on the financial state of the organization. According to the accounting principle of integrity, financial reports should not be tampered with even if it means that investors will avoid the company. The temptation of interfering with financial reports so that they do not show the true state of an organization is a common temptation of CEOs of publicly traded companies because recovery without the support of the investors is not always easy. Enron fell to the trap and ended up destroying the image that they have strived to build. By the time the scandal was being publicized, it was almost impossible for the company to recover, as evidenced by the rapid fall in the value of shares that was experienced over the two months that followed.

The failure of the company to disclose the state of the organization also implies that they violated the ethical principle of respecting the rights and dignity of stakeholders. Investors and other stakeholders have every right of knowing the financial state of the company. The fact that the company was falsifying records was an indication that the investors have to know about the financial performance of the organization. This is the main reason why they decided to give them the altered details so that they can be able to give the wrong impression on the performance of the organization. Furthermore, they intended to mislead the external auditors into believing that they were doing well financially. The investors also had the right of knowing all the debts that the company had because it is part of their liabilities.

The Enron scandal can be used in showing the extent to which corporate governance is important to an organization of this size. This is because this scandal is an example of a failure that comes as a result of corporate governance failure. Corporate governance can be simply defined as the process through which corporate organizations are directed and controlled. There should always be ways in which the activities and powers of the executives and an organization such as Enron can be put under check. The board of governors in an organization such as Enron has the responsibility of overseeing corporate management. The failure of corporate governance at Enron can be proved by the fact that the board of governors allowed some of the executives to create companies that will do business with Enron despite the fact that conflict of interest would have been obvious. This is an implication that the board did not even take their time to review the companies that they were doing business with. Furthermore, corporate governance failure is seen in the fact that the board did not make sure that the powers of the executives, especially the CEO were controlled. Much of the manipulations of records took place because of the powers that eth executives were entrusted with.

Evidently, the Enron Scandal qualifies as a case of accounting fraud that was aimed at painting a positive picture of the financial health of the organization despite the fact that the organization was not healthy financially. As seen in the discussion herein, the accounting fraud that Enron was involved was highly encouraged by failure in corporate governance. The ethical issues that emerged, in this case, are integrity and respecting the rights and dignity of stakeholders.

 

References

  1. Agrawal, A., & Cooper, T. (2015). Insider trading before accounting scandals. Journal of Corporate Finance, 34, 169-190.
  2. Albrecht, C., Holland, D., Malagueño, R., Dolan, S., & Tzafrir, S. (2015). The role of power in financial statement fraud schemes. Journal of Business Ethics, 131(4), 803-813.
  3. Lin, C. C., Chiu, A. A., Huang, S. Y., & Yen, D. C. (2015). Detecting the financial statement fraud: The analysis of the differences between data mining techniques and experts’ judgments. Knowledge-Based Systems, 89, 459-470.
  4. Ni, A., & Van Wart, M. (2015). Corporate Social Responsibility: Doing Well and Doing Good. In Building Business-Government Relations (pp. 175-196). Routledge.
  5. Tassadaq, F., & Malik, Q. A. (2015). Creative Accounting & Financial Reporting: Model Development & Empirical Testing. International Journal of Economics and Financial Issues, 5(2), 544-551.

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Enron Scandal: The Case of Accounting Fraud. (2022, Apr 23). Retrieved from https://paperap.com/enron-scandal-the-case-of-accounting-fraud/

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